Accessing and Maximising Entrepreneurs Relief On A Company Sale

A guide on the tax efficient way to sell your small business

It is often on a disposal of a business where tax considerations can have a considerable impact and with good planning, business owners can achieve a tax efficient exit.

Entrepreneurs relief (“ER”) is often the key consideration for shareholders in achieving such a tax efficient exit and this article summarises some of the common tax issues and opportunities that business owners should consider in preparing for an exit.

Entrepreneurs relief – what is it?

ER provides for a 10% rate of capital gains tax on qualifying disposals up to a lifetime limit of £10m. This is clearly an attractive rate of tax for UK resident individuals and ensuring that this relief can be utilised as well as maximising use of the lifetime limit are key considerations to business owners on an exit.

Accessing entrepreneurs relief

On a sale of shares, ER applies where an individual holds at least 5% of the ordinary share capital (as well as 5% of the voting rights) of the business and is an officer or employee of the business throughout the 12 month period prior to disposal. The business must also be a trading company or holding company of a trading group.

Enterprise management incentives

ER can also apply where an individual acquires their shares through an enterprise management incentive (“EMI”) option scheme. In these cases the rules are significantly relaxed with the employee not needing to hold 5% of the ordinary share capital or voting rights, with no minimum holding required, and the period from the date of grant of option to the share disposal being no less than twelve months.

EMI schemes allow an employer to issue share options to employees as a method of attracting key people, rewarding them for good performance and encouraging them to stay with the business. It is an HM Revenue & Customs “approved” scheme and therefore there are certain conditions that must be met for an option to be a qualifying EMI option which is outside the scope of this article.

Entrepreneurs relief: key considerations

As a result of the above conditions there are some key considerations that individuals should be aware of when seeking to access ER:

1. Take care that a shareholding is not diluted below 5%, such as on the vesting of share options which are exercised prior to disposal.

2. Ensure that they do not resign as an employee or director prior to sale of the shares. The timing of resignation of directorship must therefore be aligned with (or after) the sale date. Particular care needs to be given on a share buy back where the effective date of disposal is not until the signing of statutory resolutions.

3. Consider the timing of associated disposals, such as property owned personally by shareholders and used by the business. A disposal of such assets can also qualify for ER where the sale is associated to the disposal of shares in a company.

4. Consider gifting shares to spouses who are, or become, officers or employees of the Company. Where they hold 5% of the ordinary share capital (and voting rights) for the 12-month period prior to sale and meet the above conditions ER can also apply to spouses with them having a separate £10m lifetime limit. Shares must be legally transferred to spouses for this to have effect. This planning can save up to £1m for the family.

6. Where a prospective EMI option holder already owns less than 5% of the company’s share capital (and so those shares do not qualify for ER) but with their EMI option they will collectively hold no less than 5%, the terms of the option might allow early exercise thereby providing the opportunity to own 5% for 12 months meaning the entire shareholding would qualify for ER (and not just his EMI shares)

How are earn-outs affected?

Further considerations must be given on earn-outs, where additional consideration is paid following a sale. Here the value of the earn-out is required to be estimated at the time of the sale and this value brought into the calculation of the gain on disposal despite the fact that it may never be received.

The temptation is to take a prudent view of the value of the earn-out in order to mitigate this upfront capital gains tax charge. However, should the earn out consideration subsequently received exceed this original estimate the excess is subject to capital gains tax at that time but without the benefit of ER.

It may therefore be beneficial to value the earn-out on the optimistic side in order to maximise the gain that ultimately benefits from ER but accepting a higher upfront tax charge. This balancing act is part of the financial planning on a sale.

Overall, with careful planning for tax on a future sale of a business, owners can reduce their tax exposure and maximize their end return through Entrepreneurs Relief.

Mark Shewring is a tax partner at haysmacintyre and advises businesses and their owners on a wide range of tax issues, particularly those preparing for an exit.

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